What level for the rupiah? October 26, 2008
Posted by Peter McCawley in Essays and Comments.Tags: depreciation, exchange rate, financial crisis, Indonesia
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The rupiah has been drifting downwards in recent days and even dipped below the 10,000 level (against the USD) on Friday 25 October. Is this a problem?
Some observers suggest that there are good arguments for action by Indonesian monetary authorities to try to hold the rupiah below the 10,000 level. The arguments in favour of this approach are that, first, confidence is a fragile thing in financial markets everywhere at present so policies need to be directed at bolstering confidence, and second, that the 10,000 mark is an important psychological level in Indonesia right now which needs to be defended if possible.
But there are strong arguments against this “hold the line” approach. For one thing, as Bank Indonesia Governor pointed out on Friday, a weakening of the rupiah is to be expected. “What is so special about the rupiah at 10,000?”, Governor Boediono said. “We should not see it only against the dollar but against other currencies. Other currencies are also lower against the dollar.”
For another thing, there are good economic arguments for allowing the rupiah to weaken at present. A decision to try to prevent the rupiah from moving below the 10,000 mark would amount to trying to maintain a de facto rupiah peg to the US dollar. It hardly seems sensible for the rupiah to be pegged to the US dollar at any time, and especially right now.
In Australia, the $A has fluctuated widely in recent months. These large fluctuations have been helpful in managing the Australian economy. The flexibility means that part of the economic adjustment needed in Australia at present has been quickly provided by the change in the foreign exchange rate. And it would surely be helpful in Indonesia as well if the rupiah were allowed to move relatively freely – including to levels significantly below 10,000 if that is seen as appropriate.
Its interesting that the RBA and BI are both selling dollars to try and stem steep slides in their currencies. I think you are 100% correct in the assertion that the level of the rupiah and dollar don’t matter too much if markets dictate that’s where they are. But clearly central banks across the region have decided that the movements we are seeing now are not warranted, other wise it is hard to understand how they are justifying to themselves winding down reserves. Especially for the RBA which has about half the reserves of BI (roughly I think).